So, what are the similarities between these long-standing government initiatives and what are the key differences?
Let us start by looking at the similarities. The key fundamentals of both EIS and VCT are:
- 30 per cent income tax relief, against income tax relating to the current tax year; and
- capital gains tax free growth, meaning no CGT being payable on exit.
That is essentially where the schemes’ similarities end.
VCT then also offers investors tax-free dividends, whereas EIS does not. However, EIS does have a number of additional facets that may be of significant interest to advisers and clients seeking some powerful tax planning.
Firstly, EIS offers investors income tax carry back relief, meaning that the 30 per cent income tax relief can be claimed against the previous tax year. This is particularly pertinent at tax-year end, after the client has submitted this previous year’s tax return on January 31 and then has a short window to get cash deployed before tax-year end to offset income tax from the previous tax year.
EIS can also be utilised to defer CGT liabilities for gains achieved within the previous three years or the upcoming 12 months.
This can be particularly powerful across a portfolio of EIS assets with CGT potentially being written off via annual allowances as the EIS portfolio achieves exits over several tax years.
EIS also offers the potential of 100 per cent inheritance tax exemption through the availability of business relief, after EIS-qualifying investment has been held for at least two years.
Further to all of these tax incentives, the EIS also offers share loss relief, which, in conjunction with income tax relief, could provide total tax relief of up to 61.5 per cent for a 45 per cent taxpayer.
As VCTs are listed funds, their shares can be subject to volatility. While this would infer that VCTs are more liquid than EIS investments, to benefit from the tax reliefs the client is required to hold VCT shares for five years. Even then, there may not be secondary trading of VCT shares so it may not always be easy to sell holdings and, of course, the value of investments can go down as well as up.
Conversely, EIS funds are products within which clients directly invest in unquoted companies. Liquidity of such assets is usually dependant on a trade sale of the company or a public listing and therefore EIS investments should be considered as being illiquid. Although you only need to hold EISs for three years to qualify for all their tax reliefs, it is unlikely that you will be able to exit immediately after the third anniversary. In reality, it could take several years before an EIS investment is realised.
VCTs tend to be more diversified than EISs as they typically invest in 30 to 70 companies. EIS investments could be held as a single investment but usually EIS funds will invest in up to a dozen companies or so, dependent on the size of the subscription.
It has been argued that VCTs are lower risk due to the impact of one company failing having less of an effect on overall returns. However, if a holding does well it also contributes less than would be the case with a smaller number of investments. So EISs have the potential for both bigger losses and gains but also potentially qualify for share loss relief.
It should also be noted that profits from the sale of a company within a VCT may be absorbed by the fund and utilised to pay tax-free dividends across the fund, thereby meaning individual investors are unlikely to see all of the upside of any successes. With EIS investments, the individual investor is the beneficial owner of the shareholding, not the fund, and therefore any upside is returned directly to the investor, subject to any fund manager performance fees. In any standard risk rating, both EIS and VCT should be considered as high risk, so any notion that a VCT is less risky should only be contextualised within the fact that both are still high risk.
The notion of risk should, of course, always be considered as a whole diversified portfolio and recently Brian Moretta at Hardman & Co wrote an interesting report on how venture capital (including EIS and VCT) should be considered in all clients’ portfolios and can be done without affecting clients’ overall risk profiles.
Historically it was perceived that EIS capital tended to be focused on the earlier stage of a company’s growth cycle than VCT funding. However, as VCTs chase growth to feed returns it is accepted that these days VCTs are often investing alongside EIS capital.
So when comparing EIS vs VCT, the important consideration for any financial adviser is, ‘What does an investor need and want?’
If income tax relief and the possibility of tax-free income is their driver then VCT should be the first port of call. However, if they want that income tax relief but also have CGT which could be deferred, are keen to ensure their holding minimises IHT liability and would like the reassurance of share loss relief, then EIS offers a far wider range of tax planning opportunities.
Given this mixture of tax planning opportunities and the potential protection of loss relief, then it could well be argued that if investors are seeking growth rather than income, then EIS should be considered more prominently in financial planning.
To utilise EIS carry back to offset income tax from the 2020-21 tax year, then cash must be deployed prior to April 5 2022.
Andrew Aldridge is partner and head of marketing at Deepbridge Capital
